Saturday, May 4, 2013

Radical reform of capitaism

There is speculation that capitalism is in need of radical reform. That may be so. It would not be the first time. Capitalism is a system which has adapted and evolved as technology and changing political structures have altered its environment.

One area for possible reform that has attracted attention is the unusual skewing of income and wealth caused by a diminishing share of economic returns to labor and a rising share to capital -- especially financial capital. Aside from the direct damage to the living standards of the working class this has the undesirable effect of reducing consumer demand to levels inadequate to maintain full employment. This produces a classic perverse feedback loop in which rising unemployment further reduces demand which further reduces employment.

If it is truly necessary for the common good to distribute the returns to capital more broadly to the general population by radical means then the way I would do it would be to (1) eliminate taxes on dividends paid by individuals who receive them from from non-financial corporations, (2) allow those corporations to charge dividend payouts against income but (3) tax them separately at a flat rate and dedicate the revenue to a trust fund for the general public with monthly payouts to be made tax free to every adult citizen that files to receive it.

Growth companies which normally would not pay dividends anyhow would be unaffected except that there would likely be more consumer demand for their products. Mature companies would be distributing their income more broadly although share holders would still benefit more than others as they would collect twice, tax free both times. The financial sector would have to adapt and probably shrink but that would be a good thing. It would have to find its proper niche investing, (i.e., lending), productively where retained earnings and equity offerings are, for whatever reason, inadequate.

I shall elaborate a bit on this last point:

There is an inherent instability in the use of corporate and household debt. Most of it has to be underwritten by collateral; i.e., assets owned by the borrower. But assets of all kinds are subject to speculative bubbles. Asset price volatility, via collateral, translates into financial markets instability. While some debt financing is certainly healthy and necessary, too much reliance of debt puts the entire economy in jeopardy.

By far, the safest form of capital investment is retained earnings. It is the means by which successful companies build on their success and branch out into related products and services. Next safest is equity as the risk of failure is mainly limited to those best able, or at least most willing, to bear it. Debt is comparatively more hazardous for the reasons already mentioned and also because the risks of failure are communicated to the broad economy through the potential and actual failures of lending institutions. Otherwise healthy enterprises can fail when their institutional creditors are unable to sustain continued financing.

Limiting the new treatment of dividends in my proposal to non-financial corporations is an important feature and should not be omitted even if there are technical difficulties in implementation.